Markets rise on U.S.-China trade. But will it last?

The U.S. says it will delay an increase in tariffs on Chinese goods and that a trade deal between the two largest economies in the world could be coming soon. What could this mean for investors and the markets? Kim Parlee talks to Jacky He, Client Portfolio Manager, TD Asset Management.

President Donald Trump said the US would delay an increase in tariffs on $200 billion of Chinese goods set for March 1 and that a trade deal between the world's two largest economies could be coming soon. But as Trump trumps up hope, China is decidedly mum on the subject.

So what does this all mean? What's really going to happen? Joining me is Jacky He. He is client portfolio manager at TD Asset Management, here to shine a little light on this. It is great to have you here.

Thank you for having me.

Let's start with, I guess-- we heard from President Trump last Sunday, tweeting out that March 1, maybe not. We also heard from Robert Lighthizer today, actually. Maybe it's going to take a little longer. But I guess you have to decide whose tweet or whose message is more important.

Is this a positive signal, do you think, at this point?

Well, if you follow Trump's tweets, then you may have a feeling like we are getting a deal tomorrow. But we feel like it's too early to say that. But at least the message of the delayed deadline is well-received by the market, because that typically signal two things-- one, the negotiation is making substantial progress, and two, both countries hope to have a deal considering the US presidential election is coming up and China hopes to stabilize their economy as well.

But regardless of an interim deal or no deal, US and China cooperation and conflict is kind of protracted and inevitable.

And part of the reason it's so protracted-- and I know you and I have talked this-- is the issues they're dealing with are not small issues. You have the issue of state-owned enterprises, forced technology transfers, cyber theft, intellectual property protection. Are any of these realistically going to get solved, do you think?

Well, that's harder to say. And it's funny-- all media is saying this as a trade war. I feel like a tech war is probably a better fit. In this tech war, certain things does have room to negotiate. The other one will have relatively limited room to negotiate.

What about-- on this tech war, where would you say there is some common ground? Where do you think they can actually make some progress?

Yeah. As you mentioned, for example, the IP protection, both China and the US agreed to enhance IP protection. We already see some tangible steps implemented by China. January 1, China established a specialized IP court at the national level. That's what the US hoped to see. And we also see China's recent draft of foreign investment law also includes a clause that proposed to ban forced technology transfer by government interference. That's also what US hoped to see. But that's not everything is their favorite.

We know the end of last year, President Xi still emphasized to enlarge, strengthen, and optimize the state-owned enterprises. That's not what they like.

And I think also, too-- not [INAUDIBLE]-- because this is the thing-- we talked with this earlier. I don't think people really realize how significant and material the state-owned enterprises are.

Yeah, exactly. I think it's helpful to understand that China and the US are running on completely different economic structures. Even post-1990s, SOEs already play a weakened role in Chinese economy. But now they still represent about 1/3 of the GDP, 2/3 of the outbound investment, and 1/5 of the labor market. So if you are a company changing the structure, imagine how many interests you need to touch. So it's hard to say they will get everything resolved just overnight. Maybe some modest concession here and there is possible, but--

Yeah. It's significant to make all those changes. So let's say they're trying to deal with these issues, which are big. You've got-- you're asking a country to change completely the way they do business, essentially, in terms of doing this. What, realistically, do you think might actually happen, then?

Well, there could be something to happen. For example, China can-- you mean how they can change this--

Yeah. Or do you expect to see a full-blown trade war?

Well, yeah.

Is that the outcome where they can't resolve it?

Yeah. OK. I just want to clarify that. Yeah. So we don't want to see that, first of all. If that happened-- and no one would benefit, for sure-- to China, the most obvious impact would be on the technology industries. For US, we shouldn't underestimate that impact either.

For example, S&P 500 operating margin, we have seen that improve over 30% since China joined WTO in 2001. That really benefit because US companies have the flexibility to outsource their lower value-added tasks to China while they can--

Cost less, yeah.

Yeah, focus more on their higher-cost tasks. That makes US companies more and more profitable and competitive. So if there's a breakdown in this global supply chain relationship, there would be some adverse impact on US companies' profitability, for sure. But what we want to say is even in the worst scenario, the world is not ending. So let's keep this show going.

Yeah. Let me ask you-- so let's even go-- whether there's prolonged negotiations or there is a full-blown trade war, both countries are going to prepare as best as they can to try and get ready for that kind of thing. So having said that, what could we see? Is it currency devaluations? What are the things that could actually happen as this gets ready?

Yeah, it's interesting. They talk about currency devaluation is probably part of the deal. We don't know how much flexibility China has to depreciate their currency. Let's say even the worst case-- let's say China gradually depreciates their currency by 5%. People worry about that 25% because that sounds a lot. But if you-- that's actually 15% higher than the current tariff. That is, if China gradually depreciates the currency by 5%, and China's companies have the ability to lower their costs, let's say, by another 5%, maybe there's only 5% left for US companies to digest.

And if you pass that 5% to end consumers, is that a huge deal as people feared in December? Probably not. I'll give you a real life example. People ask my five-year daughters, what do you do after school? Well, they literally said, gymnastics, swimming, and dollar store.

Yes, dollar store.

Yeah, exactly, because I do take them to dollar store to reward their hard studying. But let's say this dollar store becomes $1.25 store. Will I still go? Yeah. I think the answer is yes.

Yeah.

I can't stand their crying.

So you have to do it.

Yeah.

Let me ask you, then-- so it's not going to change your daughter's behavior. The question is does it change larger behavior in terms of companies, in terms of what they're doing too? Where does this leave an investor? How does an investor have to prepare for this kind of thing?

Yeah. I think investors are always worried about headlines, volatilities, things like that. I think history is a good lesson. If you look back, even during the Cold War-- I have a chart. Even during the Cold War, the US equities do deliver pretty solid returns. As long as investors keep a long-term investment perspective rather than a short-term speculation mindset, they should get some corresponding returns.

All right. Let's bring up that chart. I think we've got S&P 500. It's annualized total return during the Cold War. And again, you're saying you can have strife, but stocks will still perform if they're good quality stocks, which brings me to my next. I know that-- any examples of companies-- just as an illustration for people, the kinds of things they should think about?

So as investment professional, our team's job is more like finding certainty in uncertain times. What certainty means to us is really high-quality companies and their stable dividends. So we want to invest in companies that not only pay dividends, but also grow dividends year after year after year. And you mentioned an example. Johnson & Johnson is a great example. It's a boring company. We like to be boring. So lots of history, a good balance sheet, stable free cash flow. And if you look at credit rating, even higher than US government.

And what's more interesting to us is the company has grown its dividend for 56 consecutive years. What that means is it's 16 years before US and China even started that diplomatic ties. So that's important, because imagine through the half-century how many market recessions happened. So the company can still not-- never cut or postpone their dividend, continue to grow it. And that's the company we want to invest in.